WH Smith has told staff that they will be penalised for seeking early retirement, as the ailing retailer moves to cut its pensions burden.

The company, which issued a devastating profit warning after poor trading over Christmas, has warned the 4,000 employees who still belong to its final-salary scheme that it is planning to impose harsher forfeits for retiring before the age of 65.

Those deciding to retire between the ages of 60 and 65 will have their pension payouts reduced for the first time. The company admitted last August that the scheme faced a £199m funding gap.

In a series of assaults on pension costs outlined to staff last week, the group also plans to ask staff to contribute up to 8 per cent of their salaries in order to continue in the scheme, which was closed to new members in 1995. Employees will be asked to pay in between 4 and 8 per cent, depending on how much they earn. If they cannot afford to do so, they will be switched to the group's alternative money purchase scheme, set up in April 1995.

WH Smith's final-salary scheme, which has 26,000 members and ranks as one of the sector's most generous, costs the company £3.5m a month, or £42m a year. It is seeking to slash its costs by one-fifth.

A company spokeswoman said: "The proposals were put forward last week. We have begun a consultation process with employees and their unions. After that we will make an assessment."

The company says it will reduce the part of an employee's pension that is attributable to the years of service between now and retirement. Penalties increase the earlier the retirement age, and for the first time employees signalling they wish to retire at 60 will have 25 per cent docked from the pension attributable to their remaining service. All entitlements already accrued would be protected.

Other proposals put to staff include a plan to stop backdating entitlements for those who are promoted. At the moment, after an employee's promotion to a better-paid job, the company backdates its new, higher entitlements to when the staff member joined the group.

The pension funding talks come at a tough time for the group, which issued a profit warning in January after failing to record any sales gains during its crucial Christmas trading period. Its new chief executive, Kate Swann, is conducting a review of the company, which is expected to lead to job losses across its retail chain, and will report back to the City in April.

This week, the company will tell record labels that it will no longer sell singles after a collapse in demand from youngsters, many of whom now prefer music downloads and ringtones.

However, the company attempted yesterday to quash suggestions that it was considering a dramatic reduction in selling space for entertainment products. Although these have been under intense competitive pressure since supermarkets began selling chart albums and DVDs at knock-down prices, a WH Smith spokeswoman said: "Entertainment accounts for 25 per cent of our business. It is a driver of sales and it is a driver of footfall. We are not pulling out."

Changes to WH Smith's pension arrangements come after criticism of executive pay and bonus schemes. Last month, one in three shareholders rebelled against Ms Swann's £2m package, which included a £220,000 guaranteed bonus to compensate her for loss of share options at her previous job as head of Argos.